The Expanded Child Tax Credit Is an Imperfect Replacement for Personal Exemptions

By Sam Brunson

Picture courtesy of Pixabay. Used under a CC0 1.0 Universal license. (It’s surprisingly hard to find a picture of a family of five without copyright restrictions!)

The conference tax bill follows both the House and the Senate bills in drastically increasing the standard deduction (from current law’s $13,000 in 2018 to $24,000). At the same time, it gets rid of personal exemptions. As Stephanie Hoffer pointed out eight months ago, eliminating personal exemptions would essentially increase taxes on families of four or more people; the more children a family had, the bigger its tax increase.

To fix that problem, the bill doubles the child tax credit from $1,000 to $2,000 per child. In addition, to get Marco Rubio’s vote, the bill provides that up to $1,400 of each child tax credit is refundable.

So do the child tax credits alleviate the problem of eliminating personal exemptions? Sometimes.

The Smiths

To see what’s happening, let’s look at a hypothetical family. The Smiths are married, file a joint return, and have three children, the oldest of whom is 12. In 2018, they have $62,912 in gross income.[fn1] They don’t itemize.

Under current law, they’ll reduce their gross income by the $13,000 standard deduction and five $4,150 personal exemptions, leaving them with taxable income of $29,162. They’re in the 15-percent tax bracket, and have a tentative tax liability of $3,421.80.

Current law provides for a child tax credit of $1,000 per qualifying child, though. So the Smiths will be able to reduce their tax liability by $3,000, leaving them with an income tax liability of $421.80. (They’ll owe more in payroll taxes.)

Under the tax bill, instead of the $13,000 standard deduction, they’ll have a standard deduction of $24,000, but they’ll have no personal exemptions. Their taxable income will be $38,912. That puts them in the 12-percent tax bracket, and they have a tentative tax liability of $4,288.44.

But under the tax bill, the child tax credit has been doubled to $2,000 per child. Not only that, up to $1,400 per child is refundable. As a result, under the tax bill, not only do the Smiths wipe out their income tax liability, but they get a refund of $1,711.56. Under the tax bill, then, the Smiths’ tax liability has gone down by more than $2,000.

The Joneses

But here’s the thing: the child tax credit maps onto the personal exemption imperfectly. For purposes of the personal exemption, a qualifying child must be 18 or younger, unless she’s a student, in which case she must be 23 or younger.

But for purposes of the child tax credit, a qualifying child must be 16 or younger.

So the Joneses: they’re economically identical to the Smiths, only their kids are a little bit older. Their oldest is 22 and a college senior, their second child is 19 and a freshman in college, and their third child is 17 and a high school junior.

Under current law, the Joneses have three qualifying children for personal exemption purposes, so they have the same tentative tax liability: $3,421.80. Because none of their children is a qualifying child for child tax credit purposes, though, their tentative tax liability is also their final tax liability.

And what happens under the tax bill? Again, they have the same tentative tax liability. And, just like under current law, their tentative tax liability is their final tax liability. The Joneses owe $4,288.44 in taxes. Not only is that about $800 more than they would owe under current law, the fact that their children are older—albeit still dependents (meaning, among other things, that they live with their parents for more than half of the year and they don’t supply more than half of their own support)—has increased the Joneses’ tax liability by $6,000 over the Smiths, who have younger children.

Even if the Joneses’ children are too old to be qualifying children, the bill provides a reduced $1,500 credit for dependents other than qualifying children; to meet the non-qualifying child requirement, however, the children would have to earn less than $4,150 in 2018.[fn2] In addition, the tax credit for dependents who are not qualifying children is not refundable.

So it’s not a foregone conclusion that the two-to-seven-year difference between a qualifying child for purposes of the personal exemption and a qualifying child for purposes of the child tax credit will be costly to families with older children, but it is possible for that gap to significantly increase the taxes of older families.

[fn1] Yes, I know, $62,912 is a very specific amount of gross income; it was the median household income in Utah in 2015. I used it for some calculations in another blog post and, instead of doing all new math here, I figured I’d reuse the math I’d already done.

[fn2] Among other things, to be a “qualifying relative” under section 152 of the Code, an individual cannot earn more than section 151(d)’s exemption amount, which is $2,000, adjusted for inflation.

Dear Sam: This is such an important piece because the “bait and switch” of the “enhanced” child tax credit (ECTC) for dependent exemptions is neither simple nor transparent to tax professionals let alone hard-working and too often struggling 99% taxpayers. I have two friendly amendments. The nonqualifying child, child tax credit (huh/yes!) is only $500 and as you describe nonrefundable so it won’t help many especially mixed immigration status families who no longer qualify for the (ECTC). I would also describe the tax rates you cite as marginal because these taxpayers get to enjoy lower rates under the current and proposed schedules, as we know there is no flat tax rate system and Richy Rich gets to enjoy these lower rates too as his income fills up each of the seven tax rate buckets before it pours into the next bracket bucket. What will be interesting to see is that these proposed changes do not for the most part take place for individuals until 2018 so any tax benefit or burden will be delayed until early 2019 when larger or smaller tax refunds hit pocketbooks. I think this will confuse taxpayers and diffuse responsibility for the burdens. So as usual TaxProfs have an increasingly heavy burden to educate, educate, educate. And for that I am especially appreciative of this blog. Thank you Sam!!!!! P.S. You could have used a picture of your beautiful 5 family pack. http://docs.house.gov/billsthisweek/20171218/Joint%20Explanatory%20Statement.pdf

This mismatch of what is a “qualifying child” (QC) for personal exemption and CTC exists now. The new tax bill gets rid of the personal exemptions, and retains that age for a CTC qualifying child at under 17. The differential tax treatment for older families and younger families is more due to the bigger CTC that younger families will be getting, not less favorable treatment to older families.

The loss of personal exemptions hits both families the same. The increase in the standard deduction should help offset that for many families (but not necessarily for those with a very large itemized deduction total.) Whether that favors the younger or the older family differently isn’t clear.

There’s a difference in how the families are treated (and I’m not convinced there shouldn’t be a difference, since older kids need to start pulling their own weight in ways younger children can’t). But it isn’t really because of the tax bill. The magnitude of the difference is bigger, but only because the CTC goes up to $2000 per QC. That’s a DECREASE to the younger families, not an INCREASE to the older ones. Right?

Ruralcounsel, if you look just at the CTC provision, yes, it represents a tax cut for younger families. But that change isn’t being enacted in a vacuum. In fact, in large part, Congress has argued that the loss of the personal exemption isn’t a big deal because it’s increasing the CTC. But that increase is mismatched to the personal exemption.

And, as I’ve said elsewhere, perhaps providing more benefits to younger families is a sound policy. If it is, though, Congress should at least explain why a family with younger children needs or deserves more tax subsidies than a family with older children, rather than trying to obfuscate its enactment of this policy.

Sam, we’re in agreement that this tax reform act doesn’t exactly do a lot for individuals, and what it does do seems mostly temporary. There’s plenty to criticize, but the CTC doesn’t seem to be one of them, IMHO.

Further, I don’t think anyone needs to further explain why younger families deserve more tax preferences … the CTC has always had an age limit on it and this act hasn’t changed what that is. There really isn’t any obfuscation. At what point does someone no longer count as a “child?” Surely you agree there is some point. And yes, it would be nice if the definition of a QC was the same for all tax purposes, but since when has the tax code been particularly consistent? So that isn’t unique to this legislation.

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